What are Dividends and How Do They Work

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What exactly is a dividend?

We often hear about dividends, shares and yields when talking about evaluating companies. One of the big misunderstandings is what dividends are, how they work and how they can benefit you as investor or shareholder.

In short, a dividend is a reward paid to the shareholders of a company for their investment in a company's equity, and it usually originates from the company's net profits.

We think we know what a dividend is, but as a businessperson it pays to know exactly how and when companies pay dividends, as well as the different types of dividends out there. As the owner and director, you should also be thinking about receiving dividends from your company. Which is better - dividends or a director’s salary? Both have different tax implications. Let’s dive in.

Dividends are regular profit-sharing payments made between a company and its investors, and the price is determined by the board of directors.  Dividends are paid according to how much stock an investor or shareholder owns, usually as a proportion to the percentage of equity owned,  and can be paid monthly, quarterly, semi-annually or annually.

Companies pay dividends for many different reasons, including to attract and retain investors.

Dividends are attractive incentives for shareholders, so that they know that the company they are investing in is profitable and that there is a good possibility of future earnings. Not all companies, however,  pay dividends, some choose to reinvest profits back into the business.

For a company to share profits with investors, it must actually have profits to share. As a result, dividends are most common from well-established companies that generate consistent revenue, as opposed to start-ups. Stocks of such companies are usually known as income stocks and pay regular dividends.

 

Different Types of Dividends:

Let’s look at the different ways in which your investment can reward you.

1. Cash Dividend

Cash dividends are the most commonly used dividend type. In this type of dividend, the dividend amount is paid by transferring a sum of money from the company directly into your bank account. Pretty straightforward. 

2. Stock Dividend

Stock dividends refer to the dividend which is paid by allocating a specific  number of shares to the existing shareholders without the company taking any kind of consideration.  These shares may then generate money in the future, or can be sold in order to generate cash.

3. Property Dividend

A property dividend is paid using non-monetary items such as assets or stock  inventories rather than directly paying cash. The company pays this dividend when it does not have enough cash reserves to pay off dividends. Needless to say this is not a good sign.

4. Liquidating Dividend

When the board of directors plans to return the funds originally contributed by shareholders as a dividend, it is called a liquidating dividend, and may be a precursor to shutting down the business.

 

Why Companies Don’t Pay Dividends

There are a number of … click here to read more.